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Andrew Sheng and Xiao Geng say without multilateral cooperation and global coordination on fiscal and monetary policies, the world economy could sleepwalk into a recession that would likely trigger more debt and financial crises, as well as proxy wars

Public Policy / opinion
Andrew Sheng and Xiao Geng say without multilateral cooperation and global coordination on fiscal and monetary policies, the world economy could sleepwalk into a recession that would likely trigger more debt and financial crises, as well as proxy wars
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Source: 123rf.com. Copyright: ximagination

By Andrew Sheng and Xiao Geng

The International Monetary Fund and the World Bank held their Spring Meetings in Washington this month amid growing fears of a prolonged worldwide recession and following a series of reports predicting that global economic growth will continue to slow.

Earlier in April, a World Bank book estimated that global GDP growth will fall below 2% this year and increase to 3% in 2024, before weakening to 2.2% by 2030, down sharply from the 3.5% average rate in the 2000s. The Bank foresees a “prolonged period of weakness” for the global economy following further declines in investment and productivity.

The IMF’s latest World Economic Outlook also warned of historically low growth, increased financial risks, and a “rocky recovery” ahead. The current wave of monetary tightening has slowed inflation but also popped several asset bubbles, triggering an interest-rate risk shock that wounded borrowers and fragile financial institutions. In one extreme (but plausible) scenario examined by the authors, higher interest rates and credit-supply shocks will pull down global growth to 1% this year.

The OECD’s predictions are slightly more pessimistic than the IMF’s, projecting that the world economy will grow by 2.6% this year and 2.9% in 2024, largely thanks to post-pandemic recoveries in China and India offsetting slower growth in the United States, Europe, and Japan. Given the escalating Sino-American rivalry, former US Treasury Secretary Lawrence Summers puts the chances of a recession in the US at 70%.

When the US Federal Reserve and the European Central Bank began hiking interest rates last year, developing economies worried about the adverse effects of monetary tightening and a strengthening dollar on the global economy. The current economic slowdown, together with the looming bifurcation of global supply chains, has compounded those concerns. In March, however, following months of quantitative tightening (QT), the Fed injected $300 billion in liquidity into cash-strapped banks to shore up confidence in the financial system following the collapse of Silicon Valley Bank. The move led capital markets to speculate that the Fed may soon revert to quantitative easing (QE) and loosen monetary policy in order to maintain domestic financial stability.

But QE is a double-edged sword. Since the 2008 global financial crisis, the G7 countries’ loose monetary and fiscal policies have led to more than a decade of relative stability for the world’s advanced economies. But they have also led to near-negative nominal interest rates and higher debt levels, fueled speculative asset bubbles, and encouraged investors to forsake long-term investments in favor of chasing short-term yields.

In addition to these trends, the massive monetary expansion that followed the 2008 crisis led to structural changes in the global financial system. First, it changed the composition of assets and liabilities on the balance sheets of central banks, commercial banks, and non-bank financial intermediaries (NBFIs) such as pension funds. According to the Financial Stability Board, the G7 countries’ share of global financial assets fell from 75% in 2008 to 62% in 2020, reflecting the rapid growth of the G20’s other members (the so-called G13).

Second, the QE decade dramatically expanded central banks’ balance sheets. G7 central banks’ assets more than tripled, rising from $5.7 trillion in 2008 to $23.5 trillion in 2020. By contrast, G13 central banks, which could not launch their own versions of QE because their currencies do not have global-reserve status, expanded their balance sheets from $6.7 trillion to $16.2 trillion over the same period, mostly due to their growing foreign-exchange reserves.

Third, post-2008 financial reforms encouraged banks to engage in regulatory arbitrage. As a result, the share of total G20 financial assets held by lightly-regulated NBFIs increased from 42% in 2008 to 47% in 2020.

Fourth, America’s net international investment position (NIIP) – the difference between foreign assets owned by US residents and US assets owned by non-residents and foreign entities – deteriorated. By 2020, Americans owed $14.7 trillion more to the rest of the world than the world owed the US, up from $4 trillion in 2008. Meanwhile, rich countries increasingly borrowed from non-G7 countries. Consequently, the G7’s NIIP deficit widened sharply, from $1.7 trillion to $9 trillion.

The result is an unbalanced financial system in which the G7 still manages global monetary policy despite being deeply indebted to the rest of the world and controlling a declining share of international finance. The economic sanctions imposed on Russia in response to its invasion of Ukraine have effectively weaponized the reserve currencies of G7 countries, spurring other countries to seek ways to boost their resilience through de-dollarization and alternative trading and payment regimes.

The COVID-19 pandemic, together with the war in Ukraine, has further exacerbated the fragmentation of the global financial system. Similarly, governments’ efforts to achieve economic security through self-sufficiency have accelerated deglobalization in energy, food, and technology markets, with the unintended effect of hampering international efforts to fight climate change.

The difference between today’s financial contagion and that of 2008 is that back then, the G20 stepped up to lift the world out of crisis. China, for example, launched a CN¥4 trillion ($586.7 billion) stimulus package – then the world’s largest – amounting to 12.5% of its GDP. But the Chinese government is not expected to repeat that this time, given that the 2008 program led to a debt binge, with local governments borrowing as much as CN¥14 trillion by 2010 and creating huge imbalances that took nearly a decade to unwind. Moreover, any G20 agreement to revive the global economy would be conditional on finding a satisfactory resolution to the US-China conflict.

In the absence of multilateral cooperation and global coordination on fiscal and monetary policies, the world economy could sleepwalk into a recession that would likely trigger more debt and financial crises, as well as proxy wars. The current situation is reminiscent of the run-up to the global recession of the 1930s, which also led to increased military expenditures and set the stage for World War II. With so much at stake, the world’s largest economies have only one good option.


Andrew Sheng, a distinguished fellow at the Asia Global Institute at the University of Hong Kong, is a member of the UNEP Advisory Council on Sustainable Finance. Xiao Geng, Chairman of the Hong Kong Institution for International Finance, is a professor and Director of the Institute of Policy and Practice at the Shenzhen Finance Institute at The Chinese University of Hong Kong, Shenzhen. Copyright: Project Syndicate, 2022, published here with permission.

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7 Comments

I found this article very interesting 

I was not aware that America is so much in debt to other countries, there has always been talk of the demise of the dollar as the reserve currency but it always seems to come out on top

They talk about all the wasteful investments in speculative assets and the rise in debt levels that are now popping all over the world , NZ included.

many of our own economists are talking about the end of inflation and everything will go back to normal in a year or two , After reading this I am even more convinced that we will see a very deep worldwide recession  that could well result in a world war

The  financial system is looking like a sandcastle just waiting to collapse 

Hope I am wrong but it doesn’t bode well

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Agree we could see a North / South Korea flareup, then China could try to take Taiwan .....  munitions are well depleted, especially tank rockets.   If I was playing world ches I would create a few flash points then finally move on the prize I really wanted.    The Strategic Oil Reserve is not as full as it should be.

 

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If war comes between China and the US it will be a naval war - not a land war as in Ukraine As far as I am aware the US navy is not involved in supplying any military  equipment to Ukraine which is depleting the US navy's ability to wage war. 

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North vs South korea..... proxy war

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South Korea has it's own arms industry that is doing just fine ...

https://www.japantimes.co.jp/news/2023/03/06/asia-pacific/south-korea-a…

South Korea may not NEED US help.

As I said any war between China and the US is going to be a naval war. The last major conflict China fought was against Vietnam in the late 70's 

 

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Any war between the US and China will be about the US trying to retain its global dominance.  We should take no part in such a war and claim neutrality.  We are neither needed for any war effort from any side (except to supply food, which we could in exchange for defensive weapons/goods/energy) nor should we involve ourselves. It would likely be a long contracted affair where nobody wins anyway with a constant threat of nuclear war.  It's likely anyway that our supply lines would be in peril so we may have to become self sufficient for some time.

Any "You are either with us, or against us" rhetoric from the US is total bull and bluster anyway - as is most of their trumped up reasons for starting wars. There would be no moral high ground from any conflict involving the two and no clear advantage to supporting either side anyway.  The neutral path would be one where we ask all parties constantly to hold discussions, not shoot each other for bad reasons on all sides.

Yes, it might mean we lose our place in the 5 eyes, but there is a reason a lot of high ranking military people from the US are retiring here. They don't want to be involved in the madness either.

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